Could skills shortages scupper house builders profit margins

One of the best performing sectors this year has been the housebuilding sector, carrying on from a fairly solid 2014 performance. After an uncertain start to the year, not surprising given the political uncertainty surrounding this year’s General Election the sector rose sharply soon after the May vote and went from strength to strength, though we have seen some profit taking since the peaks seen in August. The big question now remains as to whether we’ve seen the bulk of the easy gains, or whether there is the prospect of significant further upside. At the beginning of the year we did see some evidence that London house prices were starting to show signs of weakness, which in some respects wasn’t too much of a bad thing given how quickly house prices were threateningly to spiral higher in 2014, amidst talk of a bubble. This also raised some concerns that the sector was becoming rather expensive, given the gains seen since help to buy was launched in 2013. The recent changes in stamp duty thresholds announced by the Chancellor last year have also helped slow down house price growth in London, while at the same time helping the lower end of the market, due to the way the changes adversely affect properties over the £2m mark. On the other hand the changes have also helped boost the cheaper end of the house price chain due to the cost savings made as a result of the removal of the slab based structure of the duty. The recent Autumn Statement could well nullify some of those positives as the Chancellor introduces a new stamp duty threshold of 3% on second or “buy to let” homes from April next year. Looking at the share price performance since the beginning of this year there does appear to be some evidence of exhaustion in the context of the strong rally seen in the sector since “Help to buy” was launched in 2013, which suggests that we might be about to undergo a significant period of consolidation. The biggest concern around the sector appears to be the sharp rise in labour costs due to the lack of skilled labour, as house builders struggle to build houses quickly enough, and this is likely to be a recurring theme going forward. While the UK government has pledged to increase subsidies to private developers, housing associations and local authorities, in order to help meet a government target of 1m new homes by 2020, all the money in the world won’t be of much use if there aren’t enough construction workers available to build them. The latest RIC’s UK construction survey showed that the industry is facing its biggest skills crisis since 1998, and it is this more than anything else which could well be a headwind to the UK housing sector and homebuilder’s future margins. In terms of broader underperformance within the sector this year, Persimmon and Barratt Developments have lagged a little bit behind, even if 15% to 25% gains year to date is still broadly positive. Barratt Developments got a boost earlier this year with its return to the FTSE100, and continues to post decent numbers, with a 20% increase in forward sales at its most recent update, with decent consumer demand across all regions. In the past two years the company has expanded its work force by nearly 40%, while January’s announcement of another 600 new jobs across the North East suggests that the company was optimistic about its prospects. Given that it is also more exposed to the lower end of the housing market it is likely to feel the benefits of the recent stamp duty changes more than most, particularly if interest rates remain at their current low levels then it stands to reason that demand for houses is likely to remain good. Even so despite all of these factors the fact remains that since the beginning of 2011 the shares are up over 500%. Persimmon shares have also enjoyed decent gains, up over 300% since 2011, but like Barratt are starting to show some signs of consolidation, against a backdrop of concern about stretched valuations. Like its peers forward sales are holding up well and given it currently plans to pay a 5% dividend any downside is likely to be limited. Taylor Wimpey’s latest numbers continued the theme of surging sales with a 22% increase in sales in the second half of this year. With a total order book of £2.1bn the company expects 2016 to perform equally as well with over 25% of new homes slated for completion in 2016 already sold. The performance of Berkeley Homes, which is much more exposed to the London property market has also been a little subdued probably as a result of the slowdown in the higher end of the market, due to the recent tax changes announced by the Chancellor earlier this year. Redrow has been the sector outperformer this year due to sharp increases in revenues and profits over the past 12 months. Since 2012 revenues have nearly doubled while profits have increased from £69m to £204m when the company announced its full year results in September. On the flip side Bovis Homes has underperformed this year despite reporting rising sales and rising selling prices, as well as a fairly healthy pipeline. The company said it was being constrained by rising costs due to labour shortages and planning delays to new high profit sites, which were shrinking its margins. With unemployment at multi-year lows and skills shortages unlikely to be plugged quickly unless by immigration, then the ability of house builders to build the houses required is likely to be constrained, not by money, but by head count. The big question as we head into 2016 is whether we can see further gains in a sector where recent price moves are starting to look a little stretched. This is clearly visible on a long term weekly chart of price action relative to the long term averages, where prices are between 50% and 70% above their long term averages. This is clearly not sustainable in the short term and as such could signal a prolonged period of consolidation or some form of correction. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

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